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CASE STUDYCan Information Systems Restore Profitability to Restoration Hardware?

Restoration Hardware is a retailer offurniture, hardware, and home acces-sories such as bathroom fixtures anddecorative furnishings. The companyis based in California; it started opera-tions in 1979 and incorporated in1987. The company sells through mul-tiple channels: a network of 103 retailstores across the United States andCanada, a print mail-order catalog,and its RestorationHardware.comWeb site. Restoration Hardware is amajor player in an industry thatincludes competitors such as PotteryBarn, Pier 1, and Williams Sonoma.Restoration employs 3,500 workers,1,400 of those full-time.

Restoration’s business strategyputs the company in a unique sectorof the marketplace. Restorationfocused from the start on merchan-dise that honors classic America. Thecompany’s original furniture and fix-tures were designed to match thedécor and form of older houses.Today, when you walk into aRestoration Hardware store, themerchandise clearly evokes imagesof the past. Many products, such asportable record players or woodentoys, are intent on inspiring feelingsof tradition, if not nostalgia, in oldergenerations of customers. Theyounger generations may recognizethese products from reruns of oldtelevision shows and movies set inthe times of their parents and grand-parents. Many of these products aredifficult to find elsewhere and theyare very appealing. Up front, thecompany knows what it wants to doand has maintained a consistentvision. According to Ed Weller, ananalyst at ThinkEquity Partners,“When you go to the stores, it’s clearthat Restoration Hardware hassomething customers want.” Manyof Restoration’s top executives comefrom merchandising backgrounds.

A significant portion of Restora-tion’s revenue stream comes from its direct-to-customer ventures.Circulation of the mail-order catalog

surpassed 30 million in 2003, with 58 percent of the catalogs earmarkedfor past customers. Mail-order catalogand Web site operations saw substan-tial revenue gains both in the fourthquarter (51%) and annual (52%)numbers for 2003.

In recent years, the company hasimproved its e-commerce software,increasing its capacity to supportsimultaneous online shoppers by8,000 percent. This upgrade to ArtTechnology Group’s e-commerce soft-ware is just one of several technologyinvestments that Restoration hasmade in its Web site. In late 2003,Restoration brought in iPhraseTechnologies to implement its OneStep natural language search andnavigation software as a replacementfor RestorationHardware.com’s key-word-oriented product search facility.The new search technology has madethe Web site more user-friendly.

In March 2004, Scene7, Inc., aprovider of dynamic imaging soft-ware, announced that RestorationHardware had adopted Scene7’seCatalog solution for its online printcatalog. Restoration now outsourcesthe entire process of publishing andhosting its print catalog on the Web.Restoration only has to provideScene7 with the print catalog inPortable Document Format (PDF).The published Web catalog includesdynamic links from areas on each cat-alog page to corresponding productpages on the Restoration HardwareWeb site. Scene7’s eCatalog solutionhas also made it possible to imple-ment advanced image-viewing fea-tures such as panning, zooming, androllover product descriptions.Additionally, customers can now usea “colorizer” feature to change thefabric style on any upholstered prod-uct that they are viewing. Such tech-nology saves Restoration from theenormous expenses that wouldaccompany studio photography of allthe different combinations of fabricand furniture. According to Scene7, its

eCatalog solution has resulted in thedoubling of Restoration Hardware’sconversion rate of browsers to buyers.

Despite a strong product line andupward growth in sales, Restorationhas not been able to make money. Bythe end of 2003 the company posteda $2.9 million net loss, down from$3.9 million the previous year. Theyear 2003 was the fifth straight yearthe company did not turn a profit.Analysts point to the less-visibleaspects of Restoration’s business,specifically its supply chain manage-ment systems and technology infra-structure, as profit drains. RussellHoss, a Roth Capital Partners analyst,states that Restoration simply doesnot “know how to make money.”Good products alone do not guaran-tee success. Retail businesses need tojuggle an extraordinarily complex sys-tem of variables to meet their expec-tations of success. The analysts con-tend that Restoration Hardware isfailing to control these variables tothe best of its ability. Among thegreatest concerns is Restoration’s abil-ity to keep its inventory in line withcustomer demand.

Over the 2003 holiday shoppingseason, same-store sales figures forRestoration experienced a drop of 3.5 percent from the previous year’sholiday season. One of the biggestculprits was a line of couches andchairs that shoppers can customize bychoosing from a selection of 50 fabricstyles, with delivery promised within 8 to 10 weeks. High demand of themost popular styles set off a chainreaction of profit-draining events.Customers had to wait longer thanthey had been told initially to receivetheir couches and chairs. In somecases, the customers simply canceledtheir orders. Other customers choseto purchase less-popular stylesinstead, with the incentive of a dis-counted price. Some of the ordersthat customers did not cancel couldnot be fulfilled in time to count in theholiday season sales figures.

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412 Part Three Organizational and Management Support Systems for the Digital Firm

In the last few years, Restorationhas implemented a repositioningplan, which involves reducing thecompany’s debt, upgrading manage-ment, weeding out poor productsfrom the product line, and closingstores that aren’t performing.Additionally, the company has intro-duced new products and remodeledits retail locations. The plan does notaddress improvements to the com-pany’s aging information technology(IT) infrastructure.

Restoration Hardware stores usepoint-of-sale equipment that is nearly10 years old. The equipment lacks thecapability to process debit card pur-chases without a physical signature,nor can it automate processes such aschecking fabric stocks when a cus-tomer makes a request for a customfurniture order. Customers placingcustom furniture orders must fill out apaper form that includes their fabricselection. Then a salesperson mustcall Michael’s Furniture (which manu-factures Restoration’s furniture) inSacramento, California, to see what isin stock.

A system polls Restoration storesnightly to aggregate sales, inventory,and pricing data to provide informa-tion that can help managers fine-tunethe company’s merchandise assort-ments. However, the system is notcapable of providing demand fore-casting. Restoration has systems tosupport “smooth warehouse opera-tions in a multi-warehouse environ-ment” consisting of three warehousesin California and one in Baltimore.

Restoration Hardware’s mostrecent annual report on Form 10-K forthe U.S. Securities and ExchangeCommission states that the companyrelies on a single vendor for its point-of-sale, merchandise management,and warehouse management sys-tems, along with the software supportrequired to maintain these systems.Restoration purchased these systemsand services from STS Systems, whichhas since become part of NSB Group,in the mid-1990s. NSB’s most recentversion of its warehouse-managementsystem is far more advanced than theversion that Restoration continues touse, with capabilities for XML-enabledprocessing of advance shipping notices

and real-time task tracking. Upgradesto the older version of the system arecovered by Restoration’s serviceagreement with NSB, but Restorationhas not taken advantage of the newtechnology. The company has also notimproved its systems for restocking itsproducts once they have been distrib-uted from the various warehouses.

Statistics show that in areas suchas frequency of inventory turnoverand gross profit margin, Restorationtrails its competitors. During the 12 months ending November 1, 2003, Restoration turned over itsinventory only 1.9 times, compared to 3.2 times at Williams Sonoma.Restoration’s gross profit margin isonly 30 percent, putting it among thelowest-category performers for itsindustry even though same-storesales for 2003 averaged 7 percenthigher than the previous year.

Restoration’s annual report paintsa picture of a complex business envi-ronment that is vulnerable to a hostof trends, restrictions, and abnormali-ties. From a competition standpoint,Restoration’s offerings place it in thesame realm as specialty stores, tradi-tional furniture stores, and depart-ment stores. At stake are customers,viable store locations, suppliers, andpersonnel. Restoration asserts thatmany of its competitors have greaterfinancial, marketing, and operationalresources for obtaining these assets,and that such hearty competition putsits financial performance and futuresuccess at risk. To stay in the raceRestoration believes that the com-pany should focus on fortifying itsmanagement, improving and in-creasing its product line, improvingcustomer service, enhancing its pre-sentation of merchandise, and main-taining competitive pricing and retaillocations.

The report goes on to say, “Oursuccess is highly dependent onimprovements to our planning andsupply chain process. . . . An impor-tant part of our efforts to achieve effi-ciencies, cost reductions and salesgrowth is the identification andimplementation of improvements toour planning, logistical and distribu-tion infrastructure and our supplychain. . . . An inability to improve our

planning and supply chain processesor to take full advantage of supplychain opportunities could have amaterial adverse effect on our operat-ing results.” The company must alsobe able to better anticipate consumertrends. Restoration does not specu-late on how successful it will be atimplementing these improvements oroffer any specific plans for doing so.

The one thing that RestorationHardware does seem sure of is thelitany of factors that could undermineits future success. These include sea-sonal fluctuations in revenue (includ-ing a dependence on peak sales andearnings from the fourth-quarter holi-day season), dependence on vendorsto supply merchandise and services,disruptions in distribution to storesfrom its warehouses, labor strife,dependence on external funding,trade restrictions and currencyfluctuations associated with foreignimports and purchases, general eco-nomic conditions, and the negativeimpacts on business of war andthreats of terrorism.

Each of these factors has its ownset of variables that adds to theunpredictability of running a retailbusiness. For example, Restorationacquires its merchandise from a poolof over 500 vendors. However, twovendors were the sources of nearlyone-quarter of all merchandise pur-chases in 2003. Restoration does nothave purchase contracts with thesetwo vendors, or with any of theirsmaller vendors. Therefore, the com-pany has no guarantee that it cancontinue to acquire the merchandisethat it intends to market in the properquantities, at the appropriate cost, orat all. Additionally, many vendorsmust have purchase orders submittedwell in advance of when Restorationwants to move its inventory to theshelves of its stores. This long leadtime leaves the company without theability to respond to sales trends,which is especially risky during theholiday season, when Restorationalso spends more money on market-ing and personnel. The companyexpects to hit certain sales highs dur-ing the holidays. Failure to do so as aresult of insufficient inventory or amiscalculation of what products will

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appeal to shoppers can have signifi-cant negative impact on the health ofthe business.

Restoration purchased nearly halfof its merchandise from foreign ven-dors in 2003 and the companyexpects the percentage of foreigngoods to rise in the future. Importinggoods adds another layer of risk fac-tors for the business. Tariffs, quotas,trade relations and restrictions, politi-cal unrest, shipping costs, exchangerates, and other variables all mitigateRestoration’s ability to maximize theefficiency of its supply chain. Thecompany must weigh the risksinvolved with importing merchandiseagainst the benefits, such as cheapergoods and the availability of prod-ucts that cannot be purchased any-where else.

Restoration’s report even pointsout that its thriving direct-to-customeroperations may not sustain its currentlevel of profitability. Decreased perfor-mance by those departments couldbe detrimental to the profitability ofthe business as a whole. Even thoughRestoration has placed great empha-

sis on upgrading the direct-to-customer operations, they remain asvulnerable to risk factors as the rest ofthe business.

Although a business such asRestoration Hardware faces numer-ous obstacles in operating to a profit,many of those outlined by the com-pany are speculation or worst-casescenarios. Nevertheless, loss of reve-nue during the key selling period ofthe year is clear evidence of a prob-lem that needs attention.

Sources: Larry Dignan, “Restoration Project,”

Baseline Magazine, February 2004;

Restoration Hardware 10-K Report for the

Fiscal Year Ending January 31, 2004,

www.restorationhardware.com; “Restoration

Hardware,” Corporate Design Foundation,

www.cdf.org, accessed April 20, 2004; “Res-

toration Hardware Increases Conversion Rates

Using Scene7’s eCatalog e-Merchandising

Solutions,” www.scene7.com/news,

accessed March 23, 2004; “Restoration

Hardware Reports Mixed Annual Results,”

Home Channel News, March 19, 2004;

“Financial Reports: Direct Business Soars at

Restoration Hardware,” Catalog Age,March 24, 2004; “Hardware Chain Makes

Progress on Restoration,” San FranciscoBusiness Times, March 18, 2004; and

“Restoration Hardware Utilizes iPhrase to

Drive Sales and Provide Industry-Leading

Self-Service Shopping Experience,” InternetRetailer, December 1, 2003.

CASE STUDY QUESTIONS

1. Evaluate Restoration Hardwareusing the value chain and competi-tive forces models. How is thecompany responding to the forcesthat influence it?

2. What is Restoration Hardware’sbusiness strategy? How well do thecompany’s information systemssupport that strategy?

3. What management, organization,and technology factors are respon-sible for the problems RestorationHardware is encountering?

4. What role does supply chain man-agement play at RestorationHardware?

5. How can Restoration Hardwareimprove its information systems tosolve its problems?

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